Price Determination

An Engineering & Managerial Economics presentation on Price Determination, topics covered were price determination under Perfect Competition, Monopoly, Duopoly and Oligopoly.

1. SUBMITTED TO:- SUBMITTED BY:- RASHMI VISHKARMA ADITI TRIPATHI(1150810003) ARCHANA DIXIT(1150810016) MUDIT MISHRA(1150810030) SAUMYA GUPTA(1150810045) BABU BANARSI DAS: ESGI

2. PRICE DETERMINATION

3. Price. D etermination Of Price. F actors Effecting Price. F actors Kept In Mind Before Determining The Price. Perfect Competition D efinition. M eaning. F eatures. P erfect Competition Vs Pure Competition. C ondition For Firms Equilibrium Under Perfect Competition. P rice Under Perfect Competition In Short Period. P rice Under Perfect Competition In Long Period. TOPICS OF DISCUSSION

4. Monopoly. F eatures. D emand & Revenue Under Monopoly. D etermination Of Price & Equilibrium Under Monopoly. P rice Determination Under Short & Long Period. P rice Discriminating Monopoly. P rice & output determination under discriminating monopoly. Oligopoly. T ypes Of Oligopoly. F eatures Of Oligopoly. S ources Of Oligopoly Market.

5. Duopoly Definition. Duopoly exists when. Best Response function. Types of duopoly. Cournot Model. Stackelberg Model. Advantages. Disadvantages. Assumption.

6. D efinition of price. D efinition of price determination. O bjectives of price determination. N eed of price determination. F actors effecting of price determination. D etermination Of Price. F actors Effecting Price. F actors Kept In Mind Before Determining The Price. PRICE

7. DEFINITION OF PRICE T he value that one will purchase a finite quantity, weight, or other measure of a good or service. OR P rice is the sacrifice that one party pays another to receive something in exchange.

8. P ricing is the process of determining what a company will receive in exchange for its product. DEFENITION OF PRICE DETERMINATION

9. M aximize long-run & short-run profit. I ncrease sales. I ncrease market share. T O OBTAIN THE TARGET OF RETURN OF INVESTMENT. C ompany growth. T o obtain or maintain the loyalty and enthusiasm of distribution and other sales personnel. OBJECTIVES OF PRICE DETERMINITION

10. M arket price serves as the adjustment mechanism to move markets to equilibrium. NEED OF PRICE DETERMINITON

11. Factors Your Cost Market Demand Your Profit Industry Standards Who is Your Client Skill Level Experience

12. DETERMINITION OF PRICE

13. The process of price determination

14. Excess demand exists when, at the current price, the quantity demanded is greater than quantity supplied. Excess supply exists when, at the current price, the quantity supplied is greater than the quantity demanded. EXCESS DEMAND & SUPPLY

15. Excess supply = Q s - Q D supply demand price quantity p = $3 Q D Q S EXCESS SUPPLY

16. Excess demand = Q D - Q S supply demand price quantity Q D Q S EXCESS DEMAND

17. W hen there is EXCESS DEMAND for a good, price will tend to rise. W hen there is EXCESS SUPPLY of a good, price will tend to fall.

18. C hanges in consumer incomes C hanges in the prices of substitutes C hanges in the prices of complements C hanges in tastes Changes in demand can be caused by

19. C hanges in prices of inputs. C hanges in technology. C hanges in taxes. Changes in supply can be caused by

20. INFERIOR & NORMAL GOODS P Q supply p q demand @ old beer price demand @ higher beer price p 1 q 1

21. D efinition. M eaning. F eatures. P erfect Competition Vs Pure Competition. C ondition For Firms Equilibrium Under Perfect Competition. P rice Under Perfect Competition In Short Period. P rice Under Perfect Competition In Long Period. PERFECT COMPETITION

22. Perfect competition is the theoretical case illustrating the most competitive market possible. PERFECT COMPETITION

23. “ P erfect Competition Exists In Markets Where There Are So Many Sellers That No One Is Big Enough To Have Any Appreciable Influence Over Market Price. ” -Prof. Bach DEFINITION

24. Both buyers and sellers are price takers. A price taker is a firm or individual who takes the market price as given. I n most markets, households are price takers – they accept the price offered in stores . T he retailer is not perfectly competitive. A store is not a price taker but a price maker. feATURES

25. The number of firms is large. A ny one firm's output is minuscule when compared with the total market. L arge means that what one firm does has no bearing on what other firms do. The firms' products are identical . T his requirement means that each firm's output is indistinguishable from any competitor's product.

26. There are no barriers to entry. B arriers to entry are social, political, or economic impediments that prevent other firms from entering the market. B arriers sometimes take the form of patents granted to produce a certain good. T echnology may prevent some firms from entering the market. S ocial forces such as bankers only lending to certain people may create barriers.

27. There is complete information. F irms and consumers know all there is to know about the market – prices, products, and available technology. A ny technological advancement would be instantly known to all in the market. Firms are profit maximizers . T he goal of all firms in a perfectly competitive market is profit and only profit. F irm owners receive only profit as compensation, not salaries.

28. Pure Competition IS ABSENCE OF MONOPOLY… CHARACTERISTICS OF PURE COMPETITION L arge no. of buyers & sellers, H omogeneous Products, F ree entry & exit of firms. PERFECT COMPETITION vs PURE COMPETITION

29. I t means the level of output where firm is maximizing it’s profits & therefore , has no tendency to change its output… FIRMS EQUILIBRIUM

30. M arginal Cost Curve should cut the Marginal Revenue curve from below. Conditions for Firms Equilibrium under Perfect Competition Marginal Cost= Marginal Revenue= Average Revenue

31. AR and MR Curves Under Perfect Competition   AR : A verage R evenue curve MR : M arginal R evenue curve D : D emand)curve AR=MR=D I t would be a horizontal line or parallel to the X-axis

32. Condition : 1 Marginal Cost= Marginal Revenue= Average Revenue MC=MR=AR

33. Condition : 2 Marginal Cost Curve should cut the Marginal Revenue curve from below.

34. PRICE UNDER PERFECT COMPETITION IN SHORT PERIOD

35. S hort Period is defined as the time period in which the firm can change its output without changing the existing plant & machinery. PRICE UNDER PERFECT COMPETITION IN SHORT PERIOD

36. P rice will be affected because we cannot increase our supply acc. to demand.. O nly variable factors can be altered.. P rice set so in the short run is EQUILIBRIUM PRICE.. FEATURES

37. P rice at which there is no tendency to change in the current situation.. Demand & Supply are equal… EQUILIBRIUM PRICE

38. P ricing Decision is influenced by these two forces of DEMAND & SUPPLY… PRICING DECISIONS

39. LAW OF DEMAND Applicable for buyers… Price is inversely proportional to the demand… Applicable for suppliers… Price is directly proportional to the supply… DEMAND & SUPPLY LAW OF SUPPLY

40. CASES OF FIRM’S EQUILIBRIUM IN SHORT PERIOD SUPER-NORMAL PROFITS SHUTDOWN POINT LOSS NORMAL PROFITS

41. SUPER-NORMAL PROFITS In situation of firm’s equilibrium MC=MR=AR AR>SAC AR>SAC

42. NORMAL PROFITS In situation of firm’s equilibrium MC=MR=AR AR=min(SAC) AR=SAC

43. Firms can also earn zero profit or even a loss where MC = MR. Even though economic profit is zero, all resources, including entrepreneurs, are being paid their opportunity costs. In all three cases (profit, loss, zero profit), determining the profit-maximizing output level does not depend on fixed cost or average total cost, by only where marginal cost equals price. ZERO PROFIT OR LOSS WHERE MC=MR

44. LOSS In situation of firm’s equilibrium MC=MR=AR AR<(SAC) AR<SAC

45. The shutdown point is the point at which the firm will gain more by shutting down than it will by staying in business . As long as total revenue is more than total variable cost, temporarily producing at a loss is the firm’s best strategy since it is taking less of a loss than it would by shutting down. SHUTDOWN POINT

46. SHUT-DOWN POINT In situation of firm’s equilibrium MC=MR=AR= min SAVC AR=SAVC<SAC AR<SAC : AR=SAVC

47. E quilibrium Price is determined at the point where the se forces are EQUAL … Q uantity demanded & supplied at this point is EQULIBRIUM QUANTITY … UNDER THE SHORT-RUN PERIOD:

48. When the price is less /more than equilibrium price , then there will be tendency of movement of this equilibrium output & ultimately equilibrium price will prevail… Demand & Supply forces counteract each other…

49. I ndustry :as price maker F irm :as price taker.   Equilibrium in perfect competition In the short run

50. PRICE UNDER PERFECT COMPETITION IN LONG PERIOD

51. L ong Period is defined as that period during which , all factors become variable factors & firms can change their scale of production… PRICE UNDER PERFECT COMPETITION IN LONG PERIOD

52. P rice that prevails in long-run is NORMAL PRICE.. S upply plays a dominant role in determination of long-run normal price.. D emand & Supply can be adjusted to every possible way as per requirement in long run.. FEATURES

53. C hange all types of fixed factors.. N ormal Price is always equal to minimum long run average cost.. S upply gets sufficient time to adjust itself according to changed conditions & demand..

54. In situation of firm’s equilibrium MC=MR=AR= min LAC AR(P)=LAC AR=LAC

55. D efinition. F eatures. T ype. D emand & Revenue Under Monopoly. P rice Discriminating Monopoly. M onopolistic competition. A dvantages And Disadvantages. MONOPOLY

56. “ A pure monopoly exists when there is only one producer in a market. There are no direct competitors. ” -According to Prof. Ferguson “ Pure or absolute monopoly exists when a single firm is the sole producer for a product for which there are no close substitutes . ” -Mc Connel DEFINITION

57. One seller & large number of buyers: U nder monopoly there should be single producer of the commodity. T he buyers of the product are in large number. O nly Seller can influence the price. Monopoly is also an industry: T here is only one firm & the difference between firm & industry disappears. FEATURES

58. Restrictions on the entry of new firms: T here are some restrictions on the entry of new firms into monopoly industry T here is no competitor o a monopoly firm. No close substitutes: I f close substitute are available then the monopolist will not be able to determine the price of his commodity as per his discretion.

59. N atural monopoly. P ublic monopoly. L egal monopoly. S imple and discriminating. A bsolute monopoly and limited monopoly. S tate monopoly and private monopoly. TYPE OF MONOPOLY

60. Graph of Natural monopoly

61. I n a monopoly situation there is no difference between firm & industry. Accordingly, under monopoly situation, firm’s demand curve also constitutes industry’s demand curve. Demand curve of the monopolist is also average revenue (AR) curve. It slopes downward. It means if the monopolist fixes high price, the demand will shrink. On the contrary, if he fixes low price, the demand will expand. Under monopoly, average revenue & marginal revenue curves are separate from one another. Both slope downwards . DEMAND & REVENUE UNDER MONOPOLY

62. Demand and revenue

63. Following facts come to light as a result of negative AR & MR: D emand rises with fall in price (AR). Hence, by lowering the price, a monopolist can sell more units of the commodity. A R is another name of price per unit, i.e., P=AR. W ith fall in price, both AR & MR fall, but falling MR is more. Rate of fall in MR is usually more than rate of fall in AR. A R is never 0, but MR may be 0 or even - ve .

64. M ain objective of monopoly is: maximum profit from sale: I t can achieve in 2 ways: f irm can either fix price i t can fix the quantity to be sold the customers. A monopoly firm fixes the price and leave the quantity to be determined by demand of customer in market During fixing the price ,monopoly firm has 2 imp conderation : n ature of demand n ature of supply of commodity. Price determination under monopoly

65. Definition: I t is a market situation in which there are many seller of a particular product but the product of each seller is in some way differentiated in the mind of consumer s from the product of every other seller . - Leftwitch MONOPOLISTIC COMPETITION

66. A: large number of sellers: B:freedom of entry or exit: C:non-price competition: D:product differentiation: Feature of monopolistic competition

67. A Monopolist avoid duplication of staff, equipments, expenses are reduced. this means lower price and consumers benefit . W hen there is single producer ,scale of production become large. large output reduced cost… A monopolist needs not spend huge sum of money on wasteful and competitive advertisement .this reduce selling cost. ADVANTAGE OF MONOPOLY

68. M onopoly leads to unequal distribution of income. I t leads restriction in output. By limitation output, one can charge a high price and make more profits. H e limits output: B y preventing new firm from entering into industry and this limitation results in high price B y destroying a portion of article already produced. B y keeping productive resources partly idle. DISADVANTAGES OF MONOPOLY

69. D efinition. F eatures of oligopoly. T ypes Of Oligopoly. C lassification of Oligopoly Market. P rice and Output Determination in Oligopolistic Market. T he Kinked Demand Curve. O ligopoly and its Efficiency. A dvantages and Disadvantages. C omparison b/w Monopoly and Oligopoly. OLIGOPOLY

70. Oligopoly is a market structure featuring a small number of sellers that together account for a large fraction of market sales. Oligopoly is derived from the Greek work “ olig ” meaning “few” or “a small number.”

71. An oligopoly is a market structure characterized by : F ew firms E ither standardized or differentiated products D ifficult entry Oligopoly

72. Oligopoly is : ‘Competition among the few.’ OR ‘Few sellers DOMINATE the market.’

73. Features of oligopoly Fewness of sellers Seller inter dependence Feasibility of coordinated action among ostensibly independent firms Price rigidity

74. Types of Oligopoly On nature of product sold, oligopoly is of two types: Homogeneous Oligopoly such as industries producing steel, aluminium,etc . Heterogeneous Oligopoly or Differentiated Oligopoly such as industries manufacturing automobiles,tv sets,computers,etc .

75. Classifications Of Oligopoly Open and Closed Oligopoly Partial and Full Oligopoly Perfect and imperfect Oligopoly Syndicated and Organised Oligopoly Collusive and Non-Collusive Oligopoly

76. Price-Output Determination in Oligopolistic Market Structures We have good models of price-output determination for the structural cases of pure competition and pure monopoly. Oligopoly is more problematic, and a wide range of outcomes is possible.

77. There are few important assumptions providing a determinate solution to the price and output problem of Oligopoly are: Some economists have assumed that oligopolists firms ignore interdependence which however helps in finding the equilibrium price and output of a particular oligopolist firm. Second assumption is that oligopolist is able to predict the reaction pattern of the rivals. Third assumption is that oligopoly firms realising their interdependence will pursue their common interest and will enter into the aggrement and work .

78. Howsoever, still we find that fixing of price under oligopoly market situation is very difficult and involves a no. of assumptions regarding behaviour of oligopoly group & reactions of rival firms to price and output changes.

79. Many oligopolistic industries exhibit price rigidity or stability . Price rigidity may be due to following reasons: (a): The oligopolistic industry has reached in a stage of maturity. (b): Firms might have learnt by experience that price war is harmful & firms have found satisfactory price level. (c): Firms have realised that they cannot increase their profit by lowering the price otherwise other firms will follow the price cut by the firm. (d): A firm may compete by non-price competition rather than reducing the price. KINKED DEMAND CURVE

80. The Kinked Demand Curve quantity $ D P* Q* It has been observed that in many oligopolistic industries prices remain sticky or inflexible for a long time . The most popular explanations for this behaviour is given by an American economist Sweezy called “Kinked Demand Curve Hypothesis”.

81. The kinked demand curve has following features: T he upper portion of demand curve is elastic. The lower portion of demand curve is inelastic.

82. If the firm raises its price above P, it faces an elastic demand curve, payoff low If the firm lowers its price below P, it faces an inelastic demand curve, payoff low Kinked Demand Curve

83. Different firms can have different MCs. As long as they fall with in the discontinuous MR, P will remain stable. Output Effect < Price Effect for price movements with the discontinuous MR curve. If MC increases enough, all firms raise their prices and the kink vanishes. Kinked Demand Curve

84. The question whether oligopoly affects economic welfare depends on whether or not they exercise market power over prices and production In competition, the level of output produced is where P=MC or MB=MC. Hence, net benefits to society are maximized. Market prices as low as possible and respond to changes in market forces. This allows prices to help direct resource allocation. Oligopoly and Efficiency

85. Large firms with strong hold over the market are able to make huge profits. Companies are capable of deciding prices as their own choice. Dominant market players are able to make long-term profits.(As market don’t allow old business to increase their shares.) High profits generated by companies can be used for innovation & development of products. Helps in lowering average cost of production of goods. Stable prices in market helps customers to plan and stabilize their expenditure. Advantages of Oligopoly:

86. There is only one dominating company,hence customers have no other choice. Small business fail to establish themselves as a brand. With presence of little competition ,dominant companies may not think of improving their products. New firms can’t enter the market easily. Firms cannot take independent decisions. The micro-economic goal of fair wealth is not fulfilled as maximum profit is made by major players only. Disadvantages of O l igopoly:

87. Monopoly Oligopoly Meaning : One seller dominates the A small no .of sellers entire market. dominate the industr y. Prices : High prices may be Moderate/fair charged. pricing . Barriers A monopoly usually exist Barriers to entry are very entry : when barriers to entry are high because of economies high. of scale. Sources of Market making ability by Market making ability because Power : virtue of being only viable of very few firms in the industry. seller in the industry. Examples : Microsoft(OS),Google Health insurers,wireless carriers,beer , (web search),DeBeers, etc. media( TV,book publishing,movies )etc. Difference between Oligoply and Monopoly

88. Difference between Oligoply and Monopoly on Output basis: In monopoly, the level of output produced is where P>MC or MB>MC. Hence, net benefits to society are NOT maximized. Market prices are higher and respond to changes in market forces. This allows prices to help direct resource allocation . In oligopoly, the level of output is somewhere between the competitive and the monopolistic outcome. As the oligopolist produces closer to the competitive solution, the net benefits to society move closer to being maximized.

89. Duopoly Definition. Duopoly exists when. Best Response function. Types of duopoly. Cournot Model. Stackelberg Model. Advantages. Disadvantages. Assumption.

90. Duopoly D efinition. D efinition. D uopoly exists when. B est Response function. T ypes of duopoly. C ournot Model. S tackelberg Model. A dvantages. D isadvantages. A ssumption.

91. A n oligopoly with two firms. OR C ontrol of a commodity or service in a given market by only two producers or suppliers. DEFINITION

92. No firm can gain by unilaterally changing its own output to improve its profit. A point where the two firm’s best-response functions intersect. DUOPOLY EXIST WHEN:

93. BEST RESPONSE FUNCTION IN A DUOPOLY Firm 1’s best-response function is Similarly, Firm 2’s best-response function is ( c 2 is firm 2’s MC)

94. TYPES OF DUOPOLY Cournot model Stackelberg model

95. COURNOT MODEL

96. Features of the Cournot Model: E ach firm chooses a quantity of output instead of a price. In choosing an output, each firm takes its rival’s output as given.

97. Finding a Cournot best-response function

98. T he First firm’s best response function is: y 1 * =30 – y 2 /2 T he Second firm’s best response function is: y 2 * =30 – y 1 /2 T aken together, these two best response functions can be used to find the equilibrium strategy combination for Cournot’s model.

99. The Cournot equilibrium

100. The Cournot Model: Key Assumptions T he profit of one firm decreases as the output of the other firm increases (other things equal ). The Nash equilibrium output for each firm is positive.

101. Isoprofit Curves A ll strategy combinations that give the first firm the chosen level of profits is known as an indifference curve or iosprofit curve. Profits are constant along the isoprofit curve.

102. Isoprofit or Indifference curve

103. From Figure 16.4 y 1 * maximizes profits for the first firm given the second firm’s output of y 2 *. Any strategy combinations below the indifference curve gives the first firm more profit than the Nash equilibrium . The result above relates to the key assumption that the first firm’s profit increases as the second firm’s output decreases.

104. Joint profit not maximized in Nash equilibrium

105. STACKELBERG MODEL

106. Stackelberg Equilibrium Q 1 Q 1 M r 1 Q 2 C Q 1 C r 2 Q 2 Q 1 S Q 2 S Stackelberg Equilibrium Note: Firm 1 is producing on Frim 2’s reaction function (maximizes its profits given the reaction of Firm 2) Cournot equilibrium

107. 123 Stackelberg Summary Leader produces more than the Cournot equilibrium output. L arger market share, higher profits. F irst-mover advantage. Follower produces less than the Cournot equilibrium output. S maller market share, lower profits.

108. L arge firms having strong hold over the market are able to make huge profits as there are few players in the market. Prevents new players from entering the market through several barriers of entry. Dominant market players usually make long-term profits in an oligopolistic environment. High profits generated by the companies can be used for innovation and development of new products and processes. Close competition between two firms. Advantages of Duopoly

109. Setting of prices may be advantageous for the firms, but if done unrealistically, it may prove to be a great disadvantage for consumers. Creative ideas or plans of small businesses in the oligopolistic market fail to realize because they cannot overcome the control of major market players. With the presence of little competition, dominant companies may not think of improving their products. Disadvantages of Duopoly

110. T wo firms are producing and selling Homogeneous product. T he firms operate at zero cost of production. E ach firm has a aim of profit maximization. M arket demand is equally divided in the two firms. E ach firm demand curve is linear. E ach firm can not supply to entire market. ASSUMPTIONS

111. ANY QUESTIONS